Thursday, February 25, 2016

An update on DISCOM Bonds

As part of the UDAY scheme, the state governments across India will assume three-quarters of discom debts over the next two years. Apart from significantly lowering their borrowing cost (current cost of 12-14% to 8-9%), it is hoped that this would relieve the discoms off the crippling debt burden. As part of the scheme, the state governments are expected to issue bonds worth about Rs 3.2 trillion (75% of Rs 4.3 trillion total discom debt) over the coming two fiscal years, with two-thirds in the first year.

In this context, Andy Mukherjee pointed to the $48 bn challenge of markets ability to absorb these bonds. Consider this. The total net market borrowings of the central and state governments for 2014-15 were Rs 4.53 trillion and Rs 2.07 trillion respectively, and Rs 4.4 trillion and Rs 2.2 trillion respectively till February 12, 2016. In other words, if all state governments join, and most the largest have already done so, the cumulative UDAY bond issuance in 2016-17 would, at Rs 2.15 trillion, be larger than the state government issuance for 2014-15.

This coupled with a higher fiscal deficit could put a massive strain on the bond markets and quickly drive up the yields on these bonds. In fact, in the first round of auctions for Rs 21,445 Cr worth 10 year State Development Loans (SDLs), yields touched 8.88%, higher than expected, and indicative of the strains likely as more bonds flow into the market. As a reflection of the widening spreads,

The SDL auction found takers at yields between 8.63-8.88% for 10-year maturity bonds. The 10-year benchmark G-sec (central government bond) yield is currently hovering around 7.82%, indicating a spread of 80-105 basis points. The spreads are sharply higher than the average spread of 39-45 basis points at the start of 2016.

One way around this, and not a very desirable one, is to summon the perennial buyer of last resort in India's financial markets, LIC. And unsurprisingly, Livemint reports that LIC and EPFO have been asked to assist in mopping up the restructuring bonds that will be issued.